A Practical Guide to the Qualified Opportunity Zone Program

Hinckley Allen Tax and Real Estate

August 14, 2018

Among the many changes and incentives contained in the 2017 Tax Cuts and Jobs Act, one of the most promising is the Qualified Opportunity Zone (QOZ) program.[1] This program was created to encourage investment in distressed areas of the country. It aims to revitalize and spur economic development in these communities by creating incentives for investors to roll over their capital gains into qualifying investment opportunities.

The QOZ program allows the governor of each state (or the mayor in the case of the District of Columbia) to designate 25 percent of the state’s low-income census tracts as QOZs, subject to certification by the U.S. Secretary of the Treasury. Because the QOZs are designated based on census tracts, specific properties within a QOZ may be more upscale than one might expect. As of this writing, all of the QOZs have been established.[2]

Investors are provided with significant tax incentives for investments in QOZs, including:

Temporary deferral of taxes on gains invested in a QOZ until the taxpayer exits the investment or December 31, 2026, whichever occurs first.

Step-up in basis, resulting in reduction of deferred taxes by 10% for a five-year holding period, and 15% for a seven-year holding period.

Permanent exclusion from taxable income of any capital gains on the QOZ investment accruing after the initial investment with at least a 10-year holding period.

Investors participate in QOZ investments by investing through a “qualified opportunity fund” within 180 days of selling any asset(s) that gave rise to capital gains. Qualified opportunity funds, which can be established by anyone, are partnerships or corporations that have 90% of their assets invested in QOZs. A taxpayer can establish a qualified opportunity fund by self-certifying and completing an IRS form.[3]

The QOZ program can be used for investments in many real estate projects or operating businesses. However, there is one important qualification: after making the initial investment, the taxpayer must “substantially improve” the property by investing an amount equal to at least 100% of the original price, within the first 30 months of ownership. This additional capital can come as debt or equity, as long as the tax basis of the property increases. Accordingly, the program is intended for development or redevelopment projects, and not “buy and hold” investments.

Although the QOZ program has been compared to the existing Section 1031 like-kind exchange program, there are many important differences such as:

The QOZ program allows investors to roll over capital gain from any source—not just “like kind” property.

The QOZ program does not require a qualified intermediary—the taxpayer can hold (and invest) its cash while locating its investment.

The QOZ program does not defer the capital gain indefinitely—the initial gain (or at least 85% of it) will be recognized by December 31, 2026, as a result, the taxpayer will eventually need to find liquidity from another source or refinance the investment to pay the deferred taxes.

The QOZ program eliminates tax on any appreciation, so long as the taxpayer has a 10-year holding period.

Follow Hinckley Allen on Twitter and LinkedIn for the latest news and updates.

[1] See Sections 1400Z-1 and 1400Z-2. Unless otherwise specified, all section references in this article are to the U. S. Internal Revenue Code of 1986, as amended, or Treasury Regulations promulgated thereunder.

[2] The formal official list of designated qualified opportunity zones was published in IRS Notice 2018-48.